By breakup of the monetary order do you mean a breakup of the Eurozone? As in retaining the Euro for the core members and having all the "weak links" (which have a tendency to multiply anyway) return to national currencies? Or a series of sovereign defaults in the peripheral countries? Or both? Or what else?

What would you think all that will mean for common Europeans north and south, in terms of their daily lives, and in terms of prospects? What would it mean for the EU as a project?

The way you are describing it, if I understand correctly, there will be no winners in this - apart from very rich speculators...

I'm just rhetorically paraphrasing Taleb's description of the investor in his war story...

Nevertheless, I'm taking at face value the claims that the EFSF doesn't have enough capital to "rescue" Spain from a market run. In the current environment, public knowledge that this is the case pretty much guarantees that an attack will be attempted.

So, the baseline scenario is one in which Spain is forced to apply for help from the EFSF and the EFSF doesn't have enough money. Then what? Will Germany, the Netherlands, Finland (by then with the True Finns installed as at least the second party in the country) allow an expansion of the EFSF's capital? Their parliaments might openly revolt even if that would be the easier way to force Spain to dismantle its welfare state, which seems to be the EPP's continent-wide goal here.

If they don't expand the EFSF, Spain would have to default on some of its debt. That would "break up the monetary order", since

The eurozone was founded on the three principles of No Default, No Bailout, and No Exit, which came into conflict during the recent financial crisis.

There are ways to avoid getting there. One is for the ECB to set a ceiling on the yield (i.e., a floor on the price) of Spanish sovereign debt in the secondary market. However, the ECB has so far always done too little and too late of this, because they always wait until the debt is in free fall before intervening, and do so only to stem the fall. This does nothing to stop a run - it just signals to speculators that their attack has been successful.

Another option is for Spanish commercial banks to manage the yield of Spanish debt in the primary market (at the auction stage) and to fund this by repo-ing the bonds at the ECB's discount window. This leads us to a different angle of attack on Spain which is to deny interbank liquidity to the banks - that is, a run on the banks rather than a run on the sovereign (or as a prelude to it). This would force the banks to go to the ECB for liquidity, and last November the ECB forced the hand of the Irish government by threatening to instantly crash the Irish banks by denying them access to liquidity. Had the ECB not done that, we wouldn't be talking about a Portuguese "rescue" since the Irish "rescue" wouldn't have happened as it did.

Spain's central bank has thrown down the gauntlet to bank regulators elsewhere in Europe, saying it plans to publish the results of "stress tests" on the country's financial institutions in the near future to clear up doubts about Spain's banking system.

Is there any conditions in the Maastricht Treaty (or any following) that says that a defaulting country will be excluded from the eurozone? Is there any legal consequence arising from the defaulting to Spain's ncil, presence in the EU council, commission, or Parliament?

Will Spain be forced out of the euro? The treaty will have to be ratified, any modification also, this would be really an atomic explosion, as all the treaties that found the European Union are interdependent. Is Germany actually willing to risk a break-up of the European Union? Is it able to survive this kind of massive destruction of the political frame in Europe?

Or will we see a default of Spain (or another country) immediately followed by the disappearance of yet another principle of the eurozone? Furthermore, I'm convinced that a default would translate as a fall in the /$ rate, and therefore a sharp rise in the Eurozone economy.

Of course they can't exclude Spain from the Eurozone - there is no explicit legal prohibition against sovereign defaults, and there is no legal mechanism for excluding a member. Default is a market solution. But the EPP supports the market only in the second person and in the abstract: It is good for disciplining other persons, or people in general, not for disciplining the EPP's Good Old Boys.

If he accompanied the default with a vigorous defense of his actions and a cogent critique of the stupidity that led him to such action he could drive a stake through the existing ideology. But he seems to be a consensus guy and shows few signs of understanding what is happening. He needs to start listening to much better advice. One source springs to mind. :-)

My guess is that it would be politically much easier to gloss over a default, using some twist that may probably be found in some treaty and then, in a few months, prepare a solution through a new treaty (as for the deficit and debt rules). Spain would be in a political mess, sure, but this wouldn't be the end of the European Union, as would be excluding a member.

I personally pray for Ireland to default first, because that would weaken the anglo-group of countries in the EU political game.

This may be so... but as you guys in Green Eire are english-talking people, it will be easier to convince the Good Bankers Guys that it was not public spending.

To be clear, I believe that there is a strong xenophobic bias in the mainstream analysis of the mediterranean crisis. So, if you allow me a bit of cynicism, if it's a bunch of white aryan guys who get dunced first, then it would mitigate this view.

The best would be the fall of Britain bank's. I'm counting on Cameron on this issue.

I believe that there is a strong xenophobic bias in the mainstream analysis of the mediterranean crisis. So, if you allow me a bit of cynicism, if it's a bunch of white aryan guys who get dunced first, then it would mitigate this view.

You're assimilating the Irish to "white aryan"? You're aware of the Irish being called "white niggers", aren't you?

In any case, the "superior race" in this here crisis is the Protestant, and the Irish are Catholic.

I apologize by the way if I sound offensive. I personally have nothing against Ireland. Nevertheless, I actually think that there is some bias in the english speaking world against Europe in a general point of view, and in particular against the south of Europe. German bankers also have this bias, and I think it's cultural, transmitted through the university, and the feeling these people may have that they belong to an elite.

I'll had that you may find quite easily this kind of behaviour in France too.

I agree with you that Iceland is doing the right thing (by now). But they get away with it because they are northern Protestants. If the Greeks did exactly the same thing, they'd be attacked by the media using all the usual stereotypes. Ireland will or will not be treated like the Greeks depending on which stereotype of Ireland the media believes in.

Is Germany actually willing to risk a break-up of the European Union? Is it able to survive this kind of massive destruction of the political frame in Europe?

that's the $64,000 question... or is that billions?

will the whole european union founder on the shoals of a few german economists and their ideology, (paranoid hangover from another age)?

whether it's greed, fear, stupidity or a combo of the above is daily discussed among the conoscenti, but the average joe does not even begin to understand the murky, opaque reasons why all the bennies of a new forged union are going to have to be sacrificed, (along with the savage austerity cuts), just because of some financial machinations w-a-y behind the curtains, whether these shadowy characters come from lichtenstein, luxembourg, or germany for that matter.

all they know is that they ~we~ have become accustomed a borderless, blended, co-operative europe, and this wonderful improvement is being endangered by a few media-obscure individuals, who will not be able to hide under the glare of public consciousness trained on these saboteurs.

if europe's future lies in the hands of gamblers trying to cover their losses through obfuscation and doublespeak, the exposure of this social criminality is a risk even they can't hedge.

we have come too far to be undone by a crew of jowly backroom pirates, it won't stand.

the only question is when enough of the discomfited public wake up and stop believing the BS, and these powerfreaks will go down. the world's too small to hide in, where can they disappear to?

the dull roar of rage is mounting every day, as more and more feel the sting of the bankers' lash. when the masses have as little to lose as the arabs, well, you know the rest...

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

Fiscal policies have a significant impact on economic growth, macroeconomic stability and inflation. Key aspects in this respect are the level and composition of government expenditure and revenue, budget deficits and government debt. Fiscal discipline is a pivotal element of macroeconomic stability. The need for fiscal discipline is even stronger in a monetary union, such as the euro area, which is made of sovereign states that retain responsibility for their fiscal policies. There are no longer national monetary and exchange rate policies to respond to country-specific shocks, and fiscal policies can better cushion such shocks if they start from a sound position.

Institutional arrangements

A number of institutional arrangements for sound fiscal policies have been agreed at the EU level, also with a view to limiting risks to price stability. These include:

the prohibition of monetary financing (Article 123 of the Treaty on the Functioning of the European Union),

the prohibition of privileged access to financial institutions (Article 124 of the Treaty on the Functioning of the European Union),

the no-bail-out clause (Article 125 of the Treaty on the Functioning of the European Union),

the fiscal provisions to avoid excessive government deficits (Article 126 of the Treaty on the Functioning of the European Union, including the excessive deficit procedure), and

the Stability and Growth Pact (secondary legislation based on Articles 121 and 126 of the Treaty on the Functioning of the European Union).

For a few weeks now, the debate about whether a bail out of an EMU country is a likely option has accelerated. A few days after we had argued in a syndicated piece for Project Syndicate which was printed by a number of papers across the world that the no-bail-out clause has no relevance in the current crisis and EU member states would bail out a EMU member with solvency or liquidity problems. Germany's Finance Minister recently added flavour to the debate. Only yesterday, it was reported that Steinbrück confirmed that EMU countries might bail-out a fellow euro-area country (read for instance Bloomberg on this).

The European Central Bank gave a thinly veiled warning to the German government on Friday not to violate the European Union's "no bail-out" clause, which prevents members of the eurozone from supporting other members that are facing rising public debt.

Jürgen Stark, ECB executive board member, told Spiegel magazine in an interview released on Friday that the clause was an "important basis for the functioning of the monetary union".

The warning follows reports that Germany was considering ways to help members of the eurozone that are facing fast-rising refinancing costs as investor fears rise about deteriorating public finances. Peer Steinbrück, finance minister, said this week that Germany would not remain inactive if the eurozone was in danger of breaking up.

Back to Daniela Schwarzer:

Let us, first of all, reframe the issue. If an EMU member country heads for a situation in which it cannot refinance its debt, it may not need a full bail out, but would indeed need financial assistance. For such an emergency action, Article 100 TEC, section 2 could be used as a legal base: "Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control, the Council, acting by a qualified majority on a proposal from the Commission, may grant, under certain conditions, Community financial assistance to the Member State concerned. The President of the Council shall inform the European Parliament of the decision to be taken." The fact that EU member countries and the EU as such is not liable for the commitments of other member states (as stated in Article 103), hence does not imply that the Treaty assumes that fellow member states should go bankrupt.

Whether by issuing Eurobonds, which Schwarzer suggests, or by means of the EFSF, this can be done.

The issue really is the political stance that results in the EU (Commission, Council and Central Bank) consciously IMF'ing the member states in difficulties.

Will somebody please tell the ECB to either stand for election or shut the fuck up about fiscal policy? It's bad enough to have a monetary theocracy that operates on a Ptolemaic view of money, without having it meddle in fiscal policy as well.

A little late for that. The last 20 years are the story of how the Bundesbank became the most influential institution in the European Union and through the German government wrote itself into the EU treaties as the most powerful instutution.

the Bunedesbank was already the most powerful institution in Europe before - just ask various governments in France until the 80s about the repeated traumas of the devaluations of the Franc against the DM, and thus the need to be as tough as the Buba. Thus the euro, to try to tie the ECB to European politics rather than to its monetarist core.

That European influence obviously is not strong enough, but the situation today would be no different with the Buba- you'd have devaluations, and I fail to see how that is any worse than austerity.

Case in point, the UK, which supposedly avoided the eurozone crisis by devaluating, and is doing even more austerity today.

But you don't want to devalue from one fixed peg to another. You want to defend an upper bound to the read exchange rate, and then use accumulated hard currency reserves to act in a discretionary manner to defend your national economic interest against speculative hot money.

Oh, and you want to withdraw rediscount facilities from all banks that assist in speculative attacks against your currency. You can't attack a currency unless you can short it, and you can't short it unless its central bank is being a sucker.

The take-away point there is that central banks either don't understand the world economy or they're complicit with the predators.

While everyone is pretending that these investor attacks on sovereign political entities which we know as nation states are somehow the fault of the nation states themselves it's impossible to deal with the political reality of what's actually happening - which is that a gang of thugs with baseball bats is kicking in the windows of democracy.

This is an extended economic Kristallnacht. It's soft violence-by-spreadsheet rather than hard violence with a fist to the face. But it's still criminal violence, with immensely destructive consequences - and not the genteel debate about financial niceties that it pretends to be.

Here's a useful graph of UK insolvencies. (The downtick last year was the result of new legislation which created a simplified pseudo-bankruptcy process for certain debtors.)

Considering that Osborne's plan seems to be to move public debt to private households, the next few years aren't going to be a happy experience for many people.

And it's not quite true that you can't short a currency unless the CB is being a sucker. The CB is just the most common sucker in a Soros attack, but any entity that has domestic currency lying around in large quantities can be the sucker.

Also, if your CB is not committing to defend a lower bound, it should be brokering currency swaps between foreign central banks and domestic firms that are considered to be of strategic importance and require imports of raw materials or intermediate goods. That way, you would minimise disruptions in the event of a Soros attack that you find yourself unable to defend against.

but that's my point - it's not obvious to me yet that the devaluation/inflation route is any less painful than the austerity route.

There was a bubble, ie a perception of more wealth than there really was, and there needs to be a downwards adjustment of sorts. The questions are how big it is, and who bears the pain.

My point is to say that the bigger problem is the allocation of pain rather than the size of the crash. Asset owners, in particular financial asset owners, are protected at the expense of workers. Austerity ensures that, but it can certainly also happen under devaluation/inflation, depending on which policies go along.

I don't think there's anything today that cannot be solved by high marginal tax rates and severe re-regulation (and breakup) of banks.

My point is to say that the bigger problem is the allocation of pain rather than the size of the crash. Asset owners, in particular financial asset owners, are protected at the expense of workers. Austerity ensures that, but it can certainly also happen under devaluation/inflation, depending on which policies go along.

I don't think there's anything today that cannot be solved by high marginal tax rates and severe re-regulation (and breakup) of banks.

How would this solve the problems of Portugal?

As I see it, the currency union means that the peripheral countries need transfers and an industrial policy or we are eventually facing the depopulation of the periphery.

If the policy happens to be suicidally inappropriate for a given government, that government can always be replaced.

However, governments are not allowed to set policy for banks and investors. Even minor restrictions, like the ones being proposed in the UK, are met with outraged howls and self-righteous huffing.

It's obvious that nation states are no longer able to act as sovereign entities. Even when pols understand what's happening, and don't choose to be complicit with it, there's very little individual governments can do.

The only workable solution is an EU-wide - preferably an international - political front to oppose investor domination.

This can't take the form of a single party or wing, but has to include senior (dissenting) figures from across the region working together and coordinating responses and actions.

This isn't likely to happen - I'm not holding my breath for it. But unfortunately I think it may be the only way to stop the neo-lib thugs before they break something permanently.

It's obvious that nation states are no longer able to act as sovereign entities. Even when pols understand what's happening, and don't choose to be complicit with it, there's very little individual governments can do.

China will continue to buy Spanish debt and will help to fund a restructuring of its savings banks, a Spanish government source said after Chinese Premier Wen Jiabao met Spanish Prime Minister Jose Luis Rodriguez Zapatero in Beijing.

The figure being thrown about in the Spanish press is 9bn to recapitalize the Cajas and an unspecified amount of debt. Wen Jiabao is quoted calling Spain "China's best friend in Europe".

Yes, political capture is the basic problem. No matter what a crisis consist of, the recepy is the same - take from the poor and give to the rich. Which leads to new crisises, more shock therapy and so on.

Asset owners, in particular financial asset owners, are protected at the expense of workers. Austerity ensures that, but it can certainly also happen under devaluation/inflation, depending on which policies go along.

Debt Asset owners are not protected by inflation. That's the whole origin of the Bundesbank policy, Austrian economics and Goldbuggery in general.

Inflation helps the owners of productive assets if higher prices allow them to pocket higher margins. Other than that, inflation is bad for the wealthy.

But that is an argument against privatising pensions, not an argument against inflation.

Inflation helps the owners of productive assets if higher prices allow them to pocket higher margins.

Except when imported raw materials make up a high part of their production costs.

Additionally, when inflation is chiefly inflation of imported food and heating fuel, that will disproportionately hit the poor.

True. But imported inflation is not amenable to fiscal or interest rate policy. The only long-term way to deal with imported inflation is import substitution or reduced dependence on the goods in question. And the short-term solution to imported inflation - interest rate hikes or austerity in order to improve (or defend) your terms of trade with RoW - works at cross purposes with the industrial policy required to reduce your import dependencies.

What is the relationship there? Pensions weren't yet privatised when this happened to pensioners in ex-communist states. Methinks this has more to do with the model of retirement funds as a pot of lifetime savings, whether private or state-run.

And the short-term solution to imported inflation - interest rate hikes or austerity in order to improve (or defend) your terms of trade with RoW - works at cross purposes with the industrial policy required to reduce your import dependencies.

Does that apply to basic food items and heating fuel?

Let me add a third problem I see with the inflation narrative: on the side of wealthy people. What inflation eats away at is the value of their assets. If they can decouple at least a good part of their income from asset prices and keep their assets (bee it gold or stocks in companies not going bust or means of production), then they don't loose anything physical, and the value of those assets will rebound in the next rally. I imagine this is not something that can't be countered with some nice taxes on wealth, but don't you agree that the rich don't automatically suffer the inflation route?

In the US we have "defined benefit" and "defined contribution" plans. One difference is that the payout of the "defined contribution" plans explicitly depends on how well the economy and the investment decisions of the provider work out, whereas the burden of coming up with the benefit remains with the provider in defined benefit plans. State sponsored pensions funds, such as CALPERS provide what they can from their investments and the State of California remains on the hook for the balance, it what CALPERS provides doesn't meet the definition.
Defined contribution plans seem to work out better for the provider than for the beneficiary. That is why there is such pressure for companies that provide "defined benefit" retirement plans to label them "unsustainable" and convert them to "defined contribution" plans. The state plans are likely to be "re-defined" benefits when all is said and done. Voters getting $20,000/yr or less from Social Security are not likely to be terribly sympathetic to retired officials getting >$75,000/yr from CALPERS.

What is the relationship there? Pensions weren't yet privatised when this happened to pensioners in ex-communist states. Methinks this has more to do with the model of retirement funds as a pot of lifetime savings, whether private or state-run.

Well, yes, the point of retaining state control of the pensions is that you can index them, precisely because the state works on cash rather than accrual accounting.

Does that apply to basic food items and heating fuel?

Suppose you want to actively reduce your import dependency on fuel. This requires you to, in the aggregate, invest more in your housing stock and industrial plant than you would under a business-as-usual scenario. Both contractionary fiscal policy and contractionary interest rate policy will impair that investment. I suppose that in principle you might reconcile overall contractionary policy with greater targeted investment if you go all-out command economy in the relevant sectors, but as long as you want to retain a monetary economy with fungible money it's hard to see how that would work in practise.

Let me add a third problem I see with the inflation narrative: on the side of wealthy people. What inflation eats away at is the value of their assets. If they can decouple at least a good part of their income from asset prices and keep their assets (bee it gold or stocks in companies not going bust or means of production), then they don't loose anything physical, and the value of those assets will rebound in the next rally. I imagine this is not something that can't be countered with some nice taxes on wealth, but don't you agree that the rich don't automatically suffer the inflation route?

Inflation is not a tax on wealth, it's a tax on lazy money. So a rich person won't automatically suffer under inflation, and a poor person won't automatically gain.

More precisely, inflation is a tax on net creditors and those wage-earners and benefits claimants that are in a weaker political position than they were when their wages and benefits were originally instituted (due to the high downward rigidity of nominal wages and benefits). It is a subsidy to net debtors and employers who are in a stronger bargaining position than they used to be. That makes it a net loss for the financial sector, lazy money and weakly organised labour, and a net gain for the industrial sector and homeowners.

Devaluation or depreciation is a tax on imports and a subsidy for exports. Overall that translates to a net benefit for people associated with primary or manufacturing industries and a net loss for people associated with the financial or service sectors.

Contractionary interest rate policy is a tax on the future and a subsidy to the present. Homeowners and the industrial sector lose, because they are capital intensive; lazy money and the financial sector win because they are capital-extensive.

Contractionary fiscal policies are a tax on labour and the industrial sector, both of which are sensitive to the state of demand.

Further, economic activity is impaired by double-digit inflation rates, appreciation of the currency, contractionary interest rate policy and contractionary fiscal policy, and boosted by depreciation of the currency and expansionary interest rate and fiscal policy (note that there is no documented gain from further lowering inflation once you've eliminated the disruption caused by impairment of the ability of the currency to function as money).

As you will see, there is no perfect overlap between any of these groups and "the wealthy" or "the poor." But it is often possible to construct combinations that will favour the groups you want to favour. A combination of expansionary fiscal policy and moderate inflation favours labour and the industrial sector while it penalises the financial sector, lazy money and benefit claimants that lack adequate political power to defend the real value of their claims. Conversely, a combination of a strong currency, low inflation and contractionary interest rates favours lazy money and the financial sector, at the expense of homeowners, the industrial sector and overall economic performance (incidentally, I think that is as good an explanation as any for why this policy combination is so popular with The Serious People).

The fact that social insurance pensions are always only a redistribution of current production among current consumers means that inflation makes social insurance look more effective than financial savings for retirement funding ~ and that is also bad for those who get a slice of financial savings for retirement, but no slice of social insurance pensions.

There is nothing sufficiently unique about Europe to exempts us from simple accounting relations. Cycle-averaged balanced budgets in a nominally growing economy impose an upwards unemployment bias by withdrawing fiat-money purchasing power from the economy, relative to the demand for fiat-money purchasing power.

Was French unemployment worse in 93-08 than it was in 78-93? Growth? General state of the economy?

Both of those periods are dominated by intra-European fixed-rate ForEx regimes (the ERM between '79 and '93, the EMU between '98 and '08), so you can hardly use a comparison between the two to test a hypothesis on the influence of floating versus fixed exchange rates.

I am not contesting that repeated devaluations in a fixed exchange rate system is a poor policy. This is, I believe, a theoretically well founded and clearly empirically validated conclusion. My contentions are that

Continuous depreciation of the currency in a floating-rate system in order to defend the real exchange rate from appreciation is not painful, as long as your financial regulator prevents people from carry trading in your currency.

When you are Soros attacked, you need to make a clear-headed judgement as to whether you will be able to defend against it or not. If you do not believe that you will be able to defend against it, you should not mount a defence - instead, you should use your currency reserves to minimise industrial disruption by providing bridging currency swaps to strategically important firms that require essential imports. Which firms are considered "strategic" and which imports are considered "essential" should be planned out ahead of time and continually revised, as should your estimate of your ability to defend against Soros attacks. Regular drills would be a good idea.

The crises in Greece, Spain and Portugal are fundamentally currency crises, not debt crises.

Now, if my third contention is correct, then the relevant comparison is between the 1993 currency crisis and the 2008 currency crisis, not between the ERM and EMU periods.

Simple inspection suggests that the 1993 devaluation was much less painful than the 2008 austerity, but in order to make a compelling case one would have to compare the magnitude of the required exchange rate adjustments to achieve real exchange rate parity with the one's choice of indicators of economic performance. I don't have 1993 price level, unemployment and exchange rate data on hand for these countries, but if you're really interested I can probably get them and run the numbers.

# the prohibition of monetary financing (Article 123 of the Treaty on the Functioning of the European Union),

No QE?

Specifically, what is prohibited is direct lending to public institutions, including buying bonds at issue. Interested parties such as ECB Chief Economist Jürgen Stark have wrongly claimed that the ECB was in violation of the treaty for buying the bonds in the secondary market.

If you want, it means no QE for the public sector. There is nothing in the EU treaties or the ECB's internal regulations to restrict QE for the benefit of the private sector, as long as it doesn't conflict with the inflation mandate.

# the prohibition of privileged access to financial institutions (Article 124 of the Treaty on the Functioning of the European Union),

Banks should get no tax payer guarantees?

All the EU prohibitions in this area apply to the public sector, not to the private sector. So "no privileged access to financial institutions for public entities". Look at the context: it's a discussion of government fiscal policy.

# the Stability and Growth Pact (secondary legislation based on Articles 121 and 126 of the Treaty on the Functioning of the European Union).

Here is the key. In neoliberalism "growth" does not mean "wealth creation." It means credit creation. And wealth distribution by asset price inflation.

Further, the SGP only constrains public finances. But if you constrain government deficit to 3% and you have countries running primary deficits in excess of 3%, the difference must come from private deficits. The result of the GSP is necessarily a private debt bubble. Or, if that is prevented as well, a recession.

Also, the only way to reduce a promary deficit is through import substitution or other industrial policy forbidden to EU member states under the "illegal state aid" rules. Only the EU as a whole, though structural funds, could legally carry out such an industrial policy. But structural funds come out of the EU budget which is roughly 1% of EU GDP. Even if all of that were directed to reducing primary deficits, it would not be nearly sufficient.

It is interesting that Articles 123 through 126 of The Treaty on the Functioning of the European Union effectively outlaw all measures that could be used to prevent a default but do not outlaw defaults. This could be used as a cogent defense of a default.